Too Big to Jail

You Have Financial Institutions Which are Too Big to Fail But Too Big to
Jail, and Frankly, Too Big to Regulate and Too Big to Manage!

FRA Co-founder Gordon T. Long is joined by Satyajit Das in discussing the
consequences of financial repression and current policy making, along with
the effects of the Chinese economy.

SATYAJIT DAS is an internationally respected expert in finance, with over
35 years' experience. Das presciently anticipated many aspects of the global
financial crisis in 2006. He subsequently proved accurate in his warnings about
the ineffectiveness of policy responses and the risk of low growth, sovereign
debt problems (anticipating the restructuring of Greek debt), and the increasing
problems of China and emerging economies. In 2014 Bloomberg nominated him as
one of the fifty most influential financial thinkers in the world.

Mr. Das is the author of a number of key reference works on derivatives and
risk management. Das is the author of two international bestsellers, Traders,
Guns & Money (2006) and Extreme Money (2011). His latest book
is A Banquet of Consequences (2015) (published in North America as Age
of Stagnation).

He was featured in Charles Ferguson's 2010 Oscar-winning documentary Inside
Job, the 2012 PBS Frontline series Money, Power & Wall Street, the 2009
BBC TV documentary Tricks with Risk, and the 2015 German film Who's Saving
Whom.

Views on Financial Repression

It started around 2008 and prices relate to debt. Fundamentally, the way the
surprises were dealt with were in a very old fashioned way to grow and inflate
their way out of debt. As we know, this process hasn't really worked, and there's
really only two choices left. One of them is to default, which is hugely unpalatable
because writing off peoples' savings like that has consequences for future
consumption, and a huge amount of wealth loss in the world. The other option
is financial repression, which is a way of managing excess debt. The most common
way is by very high levels of taxation.

"I don't think people, when talking about financial repression, are talking
about taxation as being something that shouldn't happen."

There's obviously a point of taxation which is to run social services and
infrastructure and government, but at some point under the condition of high
debt it starts to bring taxation rates up for the simple reason of using the
state to absorb everyone's debt, in other words socialize the debt and then
try to use the taxes to pay it off. That can be hugely unproductive for the
economy but we're starting to see it happen around the world.

The next stage is what we call financial repression, where we start to devalue
the debt. The most important way we can see that is through a period of low
interest rates.

"People forget that since 2008, we've had over 600 interest rate cuts
globally. Interest rates are pretty much around zero around the world."

Roughly 30% of global government bonds are trading at negative yields. Either
you have nominal yields that are positive but below the rate of inflation to
use that to try and ease the purchasing power of debt. Alternatively as we're
now finding that because inflation is low and the debt levels are so high,
we've gone to negative interest rates. There's something perverse about negative
interest rates because people get very technical about it. This is actually
a way of writing down the debt, and are very dangerous, as the market's reaction
to the negative interest rates in Japan and Europe have proven.

Firstly, there's no real proof that these types of policies are going to create
growth or inflation. They've been put in place to write down the debt. First
we have -5% interest rates, and after ten years we've written off half the
debt. That's now a sort of stealth tactic the central banks and policy makers
have put in place. Everybody knows that they said, look, in the next crisis
we're going to cut interest rates and interest rates are so low that we're
going to have to go to negative territory, but we all know that if we go to
negative territory people are just going to take money out of the bank and
just hold the cash.

"They're going to have to stop people from taking out cash, and the interesting
way that's being channeled by policy makers is that they're pretending
that banning cash is necessary to prevent criminality or terrorism."

There are also other forms of financial repression as well, like redirecting
investment. There's a whole variety of these measures that we see come into
play, and it all has to do with the fact that they try to use these measures
to deal with the debt crisis.

"I would argue that it's not going to be able to be dealt with, and it
creates enormous social and political pressures... What we're going to
see is a period of financial repression, which is very, very dangerous."

Political Extremism and Policy Making

We're starting to see signs of this via the political extremism that's starting
to come about. The reason these popular extremist policies are being promoted
in the United States and elsewhere is because financial repression and the
lack of honesty of dealing with the world's financial and economic problems.

If you look at this period of history and the way the Europeans have deal
with the European Debt Crisis, it's almost single-handedly created parties
like Ciudadanos in Spain, but in Germany these policies would never
have gotten any sort of traction. Even the German Finance Minister has said
that these parties are really the creation of the economic policies that people
are playing around with, and that's setting up this confrontation we see in
play between Germany and the European Central Bank.

"I honestly don't know how it's going to end. In the 1920s and 1930 when
similar pressures built up, it didn't actually have a very good ending."

Thoughts for The Next Year (12-14 Months)

"I think, fundamentally, we know what the problems are: it's debt."

It built up in the system, it's not properly funded, we know the global imbalances
are unsustainable, and add on top of that the financialization of the economy
where people are rewarded for trading claims on real cash flows and
real assets.

"You have financial institutions which are too big to fail but too big
to jail, and frankly, too big to regulate or too big to manage."

So all of those we know, and on top of that there's climate issues, resource
scarcity, so we've got a very toxic set of problems. Things are going to play
out in one of three scenarios. One is the 'Lazarus economy', where all the
skeptics are wrong and everything goes back to normal. It's not likely, but
it might happen. The most likely one is a period of stagnation, which might
happen with a 70% chance. What happens is we're stuck in this environment of
very low growth, disinflation, the debt keeps building up, we use policies
like financial repression and low interest rates in a predominant way, and
we stretch this out for as long as we possibly can. One lesson we learned from
Japan is that we can't do this for a very long time. The policy makers are
going to try to keep this game going for as long as possible. The problem is
that it's not sustainable.

The last scenario is the one with the 30% chance, which is the crash. The
question is whether that happens suddenly, or if we get gradually to where
the system breaks down. You have all these nodes of instability going on and
it's all held together by chicken wire, which is basically central banks putting
more and more money in and coming up with more and more far fetched and less
effective schemes.

The crucial thing that people forget is that this is the ultimate act of faith.
The central bankers who completely misread things in the lead-up to 2007 and
contributed to the crisis have suddenly after that becomes the saviors.

"At some point in time it'll turn into, 'oh dear, the emperor has no
clothes, they don't actually know what they're doing'."

What people need to keep in mind is that it'll be very different from 2007-2008.
The problem is much bigger, and the emerging markets that were a source of
strength in 2008 and provided demand for the people in advanced economies,
along with abundant savings that helped push the problem, are no longer a source
of strength. The third thing is the fact that the policy makers are all wrong.
The social and political pressures are in a much worse place than 2007-2008
and socially the tensions are starting to build up.

"Whatever happens now will be far more difficult to control than they
were in 2007-2008 and I think essentially we are at a very dangerous inflection
point... And the one thing I do know is if something cannot go on, it won't
go on, and if something happens it happens suddenly."

The central banks have this under control for the moment, but in complex systems
they tip over extremely suddenly and extremely quickly, and none of us know
what the trigger will be, but there will be a trigger and in hindsight it would
be obvious it was the trigger.

"Everyone now is chasing risky assets because it's the only way they
can feed themselves."

Investment Direction and Preparation

"In this crazy world of the 1980s onward, we sort of reversed priority
and put capital gains first, income next, and security of capital last."

You have to think about how to recover, rather than worry about capital gain.
One of the key things is to find things that people need: food, oil, scarce
resources, and guns (security).

"You're looking for areas that are absolutely crucial in the terms of
the actual needs of ordinary people, and that will be protected."

The policies are hugely repressive because they're forcing people to take
risks with their savings, and intentionally they're going to go broke or grow
poorer over time.

"I'm actually astonished, when you mentioned pitchforks earlier, that
investors haven't picked up their pitchforks and gone after some of these
policy makers, though given time I suspect that's going to happen."

Views on Chine

The pre-2008 period was very sound, but after that the Chinese Public Bureau
placed a strong emphasis on social stability and launched a program to create
employment opportunities. What that's done is increased the amount of debt
in China. In 2000 the amount of debt was $2T. In 2007 it went to $7T. In 2014
it's $28T. It's gone up by a factor of 14 times.

"You can't have that kind of growth being leveraged by debt in a financial
system without consequences."

If you look at where the money's gone, it's this massive overcapacity in their
industries, there's a lot of real estate; about 15-20% of China's GDP is tied
up in real estate. It's inevitable that they're going to have some problems.
The last few debt crises that happened in China, the States stepped in, created
asset management companies, bought the bad loans to the banks, selected government
guarantees on some bonds, and sold it back to the same banks and let time to
take care of the problem.

The problem now is the bad debt problem is much larger, and they're not going
to have the same GDP growth that they had. The way that they're trying to deal
with this is by keeping deposit rates low and the system very liquid so the
banks can gradually absorb these losses.

"I think the best case is that China becomes like Japan, which is putting
all these bad debts on their balance sheet and gradually slowing down."

The problem is if they miscalculate, the problem is bigger and comes upon
them in a way that is much quicker that you could potentially get a banking
meltdown. The problem with that is that would spread from China out very quickly
because there's about a trillion dollars of exposure that far end lenders have
to Chinese banks and Chinese companies.

Gordon T. Long has been publically offering his financial and economic writing
since 2010, following a career internationally in technology, senior management & investment
finance. He brings a unique perspective to macroeconomic analysis because
of his broad background, which is not typically found or available to the
public.

Mr. Long was a senior group executive with IBM and Motorola for over 20 years.
Earlier in his career he was involved in Sales, Marketing & Service of
computing and network communications solutions across an extensive array of
industries. He subsequently held senior positions, which included: VP & General
Manager, Four Phase (Canada); Vice President Operations, Motorola (MISL -
Canada); Vice President Engineering & Officer, Motorola (Codex - USA).

After a career with Fortune 500 corporations, he became a senior officer of
Cambex, a highly successful high tech start-up and public company (Nasdaq:
CBEX), where he spearheaded global expansion as Executive VP & General
Manager.

In 1995, he founded the LCM Groupe in Paris, France to specialize in the rapidly
emerging Internet Venture Capital and Private Equity industry. A focus in
the technology research field of Chaos Theory and Mandelbrot Generators lead
in the early 2000's to the development of advanced Technical Analysis and
Market Analytics platforms. The LCM Groupe is a recognized source for the
most advanced technical analysis techniques employed in market trading pattern
recognition.

Mr. Long presently resides in Boston, Massachusetts, continuing the expansion
of the LCM Groupe's International Private Equity opportunities in addition
to their core financial market trading platforms expertise. GordonTLong.com
is a wholly owned operating unit of the LCM Groupe.

Gordon T. Long is a graduate Engineer, University of Waterloo (Canada) in
Thermodynamics-Fluid Mechanics (Aerodynamics). On graduation from an intensive
5 year specialized Co-operative Engineering program he pursued graduate business
studies at the prestigious Ivy Business School, University of Western Ontario
(Canada) on a Northern & Central Gas Corporation Scholarship. He was subsequently
selected to attend advanced one year training with the IBM Corporation in
New York prior to starting his career with IBM.

Gordon T Long is not a registered advisor and does not give investment advice.
His comments are an expression of opinion only and should not be construed
in any manner whatsoever as recommendations to buy or sell a stock, option,
future, bond, commodity or any other financial instrument at any time. While
he believes his statements to be true, they always depend on the reliability
of his own credible sources. Of course, he recommends that you consult with
a qualified investment advisor, one licensed by appropriate regulatory agencies
in your legal jurisdiction, before making any investment decisions, and barring
that, we encourage you confirm the facts on your own before making important
investment commitments.

The information herein was obtained from sources which Mr. Long believes reliable,
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